New Simplified Tax Regime: Should You Opt For It?

Over recent years, the Indian Government has taken several measures to amend the existing income tax laws to bring more transparency and to simplify compliances for taxpayers. Budget 2020 has been another milestone to elevate this tax simplification process.

A key takeaway from the Budget has been the introduction of a new personal tax regime for individual taxpayers. The Finance Minister (FM) tabled a proposal wherein an individual taxpayer could make an election between the two personal tax regimes – existing or new. The proposed new tax regime offers lower tax rates for different income slabs of individual taxpayers. However, it comes with a rider to forego several tax exemptions and deductions which are otherwise allowable for investments/contributions made by the taxpayers. As per the FM, around 70 exemptions and deductions are removed in the new simplified tax regime. The overall benefit to the taxpayer under this tax regime is transformed in the form of lower tax rates. 

Each individual needs to assess the regime and determine whichever is more beneficial to them by considering the cost of investments and the tax-savings. The election of the tax regime, i.e. existing or new, will have to be made by the individual taxpayer at the time of filing the annual tax return. This election will be made for each tax year, if the individual’s income does not include business income. In case of business income, the tax regime election once made will be applicable to all future tax years, subject to certain conditions.

There are other key aspects which need to be considered by the individual taxpayer. Some of them are discussed below.

Considerations for individuals underemployment

Under the existing tax regime, the onus is on the individuals to claim tax exemptions and deductions for eligible contributions & investments. Typically, an employee is required to provide declaration and supporting documentation to the employer. This enables the employer to consider the employee’s investments and deductions at the time of processing payroll and to make necessary tax deductions from the employee’s salary. However, the Budget has not made any corresponding changes in the withholding tax provisions i.e. Section 192 of the Income-tax Act,1961. Given the situation, it remains a dilemma whether an employee needs to make a declaration of the tax regime option to his employer as well as the manner of such declaration. In true essence, the withholding tax provisions need to be modified to allow appropriate tax computation by the employer and thereby, avoid excess tax deductions from employee’s salary. It is expected that the procedural aspects of the new tax regime would be clarified by the Government soon.

Ebbing of deductions for housing loan

Under the existing tax regime, a taxpayer can avail a deduction for the payments made towards housing loan repayments (principal and interest). However, under the new tax regime, no deduction for housing loan repayment shall be available. This may not prove to be lucrative for most middle-class taxpayers who have already made investments in the real estate sector. For a salaried taxpayer, this is a major expenditure head. The previous Financial Budgets had reduced the deduction limit for this expenditure whereas the new tax regime has completely done away with these deductions. 

Investments to be no more tax-beneficial

Presently, the income tax laws allow a deduction for various investments, thereby reducing the taxable income base of the individual taxpayer. Some of these investments include life insurance premium payments, investments in Equity Linked Savings Scheme (ELSS), term deposit for 5 years or more with scheduled banks, investments in Public Provident Fund (PPF) and Sukanya Samridhi Account, etc. The financial market in India is flooded with a range of such tax-savings deposit and insurance schemes like ELSS plans, the Government-backed Sukanya Samridhi Account, etc. These help an individual to plan their financial investments while offering some tax relief.

The new tax regime’s idea of a simplified tax structure may not induce more investments as deductions would not be available under this regime. This may prove costly for taxpayers who have already invested in various schemes. While tax savings should not be the sole factor for a taxpayer to plan future investments, the taxpayer will continue to have a cash outflow for these investments but will not be able to claim a deduction for the same. 

Social security pinch for high taxpayers 

For a country with a population of over a billion, it necessitates the need for a robust social security system. The main social security funds in India are the Employees’ Provident Fund and Pension Scheme. This is also followed by the Superannuation Fund and other voluntary schemes such as the National Pension Scheme. These retirement-cum-savings schemes ably suited a majority of small taxpayers by providing tax benefits and the necessary social security cover.

Presently, the employer’s contribution to Employees’ Provident Fund account in excess of 12% of basic salary is treated as a taxable prerequisite for employees. Similarly, an employer’s contribution to Superannuation Fund in excess of INR 1.5 lacs is taxed in the hands of the employee. The employee is also provided a deduction for the employer’s contribution of up to 10% of salary to the National Pension Scheme.

As per the Budget 2020 proposals, the employer’s aggregate contribution to Employees’ Provident Fund, Superannuation Fund and National Pension Scheme exceeding INR 7.5 lacs shall be taxable in the hands of the employee. Further, any annual accretion in the nature of interest, dividend or any other nature on the employer’s contribution shall also be taxable.

Under the new tax regime, the employee will have to forego the deduction for the personal contribution made to Provident Fund account i.e. up to Rs 1.5 lacs. With the introduction of a combined upper limit for deduction in respect of employer’s contribution towards the above social security funds, the high taxpayers will have a higher tax outgo.

Concluding Remarks

The FM mentioned during her Budget speech that the tax proposals in the Budget are in continuation of the reform measures taken by the Government so far and they aim to stimulate growth, simplify tax structure, bring ease of compliance, and reduce litigations. While the new tax regime promises to streamline the tax law, it is imperative to have a robust personal tax system that also supports the economical sentiments of taxpayers. It remains to be seen how beneficial and practical it may prove for each individual taxpayer.